What the Future holds for Bitcoin and Virtual Currencies

Bitcoin has seen its reputation in the eyes of the general public drop following various security breaches (i.e. Mt Gox) that have left many uncertain about the digital currency’s legitimacy and future. In addition, people are starting to question if Bitcoin really has a place in the market and if there is actually a problem that it solves – there is almost a malaise in the eyes of many who are getting tired about reading about it. Although Bitcoin might be hitting headwinds, security enhancements are underway and blockchain technology seems to be thriving.

Consensus Algorithms

For digital currencies to function successfully without a central authority, transactions must rely on consensus in order to agree on the validity of past transactions and the integrity of the system. With bitcoin, this is currently done through mining, which verifies transaction and then subsequently saves them on the publicly agreed upon ‘blockchain’ ledger.

Some companies have examined how globally disconnected networks can agree on a valid transaction without the traditional proof-of-work mechanism. Ripple Labs, for example, has developed an election-based protocol, whereby each transaction is validated by a list of nodes that agree on whether or not the transaction is authentic or not through a digital election system. Transactions agreed upon by the network are confirmed and made permanent through a new ledger if more than 80% of nodes validate the transaction after several rounds of election.

Ripple selects nodes to participate in the election process from a mixture of nationalities, industries and ideologies, and through trust scores ensures that at least 80% of all nodes verifying a transaction are non-colluding, thereby maximizing the probability of correctness of a transaction.

In addition, it bypasses the compute-intensive calculations that bitcoin mining currently operates on, allowing for lower-cost and more efficient methods of global payments and money access. This protocol works for any digital transaction, be it crypto currencies or fiat currencies. This so-called Ripple Protocol Consensus Algorithm (RPCA) is one of many protocol innovations that have enhanced security and efficiency in decentralized transactions.

BitCoin 2.0

Alongside innovations surrounding consensus algorithms, digital currency developers are harnessing the innovative bitcoin blockchain technology and are building tools on the underlying protocol; so-called BitCoin 2.0 innovations. Bitcoin’s blockchain is built so that trust is ensured within the system, which gives rise to applications that are able to replace the tasks of traditional intermediaries such as banks, exchanges and escrow services. Eliminating fee and commission expenses poses interesting business opportunities and alleviates customers’ transaction costs.

Smart Contracts

These Bitcoin 2.0 innovations have lead to the introduction of so-called ‘smart contracts.’ Smart contracts are contracts that are translated into code, which formalize and secure commitments between two parties.

For example, a mortgage contract could be enacted using a smart contract potentially saving on legal fees for consumers. The protocol would carry out the payment and ensure (digitally) that all parties are adhering to the inherent clauses of the smart contract. If both parties agree on the smart contract, the contract is irreversible and so automatically executes the commands that the algorithm has been given.

These digital protocols avoid the need for lengthy legal contracts, which traditionally involved expensive administrative services of lawyers and bankers. Although it does not completely replace traditional legal systems, it is said that it would augment the current system by facilitating legal disputes.

Ripple Labs is working on its own smart contract protocol called Codius and faces competition, mainly from Ethereum. Although both are open source projects, they differ slightly in their execution. While Codius is interoperable with other digital ledgers and fiat currencies, Ethereum uses its own separate currency to enable its smart contract service, effectively replacing other digital currencies.

Smart Property

Some developers are taking smart contracts one-step further and are making advances in smart property technology. These tools allow smart contracts to communicate with interconnected real-world objects or so-called “smart property”. Smart property could represent ownership or control of a networked object, in the form of a car or house, for example.

Continuing our mortgage example: in case a mortgage payment is not paid in a timely manner, the smart property protocol could block access to the not-yet-paid house by communicating to the “networked” key that part of the contract has been breached. The ownership of the house would be digitally repossessed and immediately passed to the mortgage-issuing bank. Access could then be restored if the mortgage payment is made.

This is already happening in certain markets like the US where ‘connected’ cars can be remotely locked-down by the bank or other vested interest parties if payments are missed. One agent we read about actually used his mobile phone while he was buying a coffee at Starbucks to lock-down the car of someone who had defaulted on car payments. Although it may seem a bit heavy-handed and has potential for abuse, it would represent significant advances in judiciary and legal matters.

Although bitcoin has had to confront some disapproval, it is hard at work to prove the critics wrong. There is an incredible potential behind the bitcoin blockchain that innovators are only now exploiting. Despite the competitive landscape looking fragmented, one thing is certain: innovation won’t stop.